Economy, not debt rating, will send markets lower

In this photo provided by NBC News, Dr. Alan Greenspan, former chairman of the Federal Reserve, and Austan Goolsbee, former chair of the White House Council of Economic Advisers, right, are interviewed on NBC's "Meet the Press" in Washington, Sunday, Aug. 7, 2011. Greenspan said he expects the stock market slide to continue Monday in the wake of a decision by credit rating agency Standard & Poor's to downgrade the U.S. credit rating. He said it will take time for the markets to bottom out, but he said he sees no risk in investing in the United States and says that S&P's downgrade won't change that. (AP Photo/NBC News, William B. Plowman)

NEW YORK (AP) — U.S.
investors will have their first chance Monday to react to Standard &
Poor's decision to strip the U.S. government of its top credit rating.
But the bigger issues facing Wall Street and stock markets worldwide
remain debt-ridden countries in Europe and concerns that the global
economy is weakening.

Friday's first-ever downgrade of U.S.
long-term debt from AAA to AA+ wasn't unexpected and may have little
impact on interest rates. But it's the kind of news that stock markets
don't need when investors are already nervous.

Even before the
downgrade, the Dow Jones industrial average last week fell nearly 700
points, or 6 percent. Investors were worried because economic signals in
the U.S. and overseas were pointing toward trouble:

—On July 29,
the government dramatically lowered its estimate of how much the economy
grew during the first quarter. It had said the economy grew at an
annual rate of 1.3 percent, but revised that number down to 0.4 percent.
Second-quarter growth was also weak, a 1.3 percent rate.

—European
officials are trying to help Italy — the world's eighth-largest economy
— avoid the kind of bailouts that Greece, Portugal and Spain were
forced to accept to prevent them from defaulting on their debt. And
those bailouts haven't solved all the problems in those countries.

—The
first reports on the economy during the third quarter have been mixed.
Manufacturing, which helped pull the economy out of the recession, fell
to its weakest level since July 2009 — the month after the recession
officially ended. The Labor Department said 117,000 jobs were created
last month. But that came after 99,000 jobs were created in May and June
combined — and 250,000 new jobs are needed each month to reduce
unemployment.

As a result, financial analysts interviewed Sunday said they expect markets to be volatile this week — and beyond.

"We
are in unchartered territory and, therefore, should all brace for
volatility over a number of days if not weeks," said Mohamed El-Erian,
CEO and co-chief investment officer of the bond mutual fund company
PIMCO.

Mark Zandi, chief economist at Moody's Analytics, said he
expected the downgrade to cause a selloff Monday. "There's a lot of fear
and misunderstanding and confusion, and that all could come out in the
stock and bond markets. I don't think it takes much to unnerve investors
given the current environment. I think anything could drive investors
to sell given how fragile sentiment is," he said.

Former Federal
Reserve Chairman Alan Greenspan, who appeared on NBC's "Meet the Press"
Sunday, expects the selling to last for some time. "It is very unlikely
that (this) isn't going to take a while to bottom out," he said.

The
reason: "It depends on Europe, not the United States," Greenspan said.
"The United States was actually doing relatively well, sluggish but
going forward until Italy ran into trouble." He said that half of U.S.
corporations operate in Europe, and that the region "has been a very
important driving force in the overall earnings of U.S. corporations."

The
Dow fell 513 points on Thursday alone after concerns about Italy's
problems were compounded by anxiety ahead of Friday's jobs report from
the Labor Department. That report came in better than expected; the
economy got 117,000 new jobs in July. But it wasn't enough to calm
investors. The Dow has fallen nearly 10 percent in two weeks — a period
that included the budget debate that averted a default on U.S. debt.

Greenspan
noted that S&P had "hit a nerve" with its downgrade. The ratings
agency said it was lowering the U.S. rating not just because of the
country's debt load, but because S&P doesn't believe Congress has
the ability to resolve the country's debt problems. And it warned that
another downgrade could be forthcoming.

On Saturday, David Beers,
S&P's global head of sovereign ratings, said his agency was
concerned about "the degree of uncertainty about the political policy
process" in Washington.

S&P was looking for $4 trillion in
budget cuts over 10 years. The deal that Congress passed on Tuesday
would bring $2.1 trillion to $2.4 trillion in cuts over that time.
S&P said it was also concerned about the ability of Congress to
implement those cuts because of the division between Republicans and
Democrats.

"Right now, the markets don't believe anybody anywhere
and the uncertainty premium is very high. Since the end of World War I,
the United States has been an unquestioned AAA credit, until now," said
David Kotok, chairman and chief investment officer of Cumberland
Advisors.

Prudential Financial market strategist Quincy Krosby
said, "The rating is in essence an indictment of Congress and puts the
president on the defensive. While both sides came up with a package that
was short on the cuts that we needed, ultimately it happened on this
president's watch. So, it takes on a very symbolic indictment of his
ability to run the United States."

Investors are worried about
debt not only because countries and many people are overwhelmed by it.
Debt is what financed economic growth for decades. Now countries and
people are cutting back on debt — deleveraging is what economists call
that process — and that means economic growth in the future will be
slower.

Economists had widely expected the U.S. economy to pick up
in the second half of the year after its soft patch in the spring. But
the stock market, which looks six to nine months ahead, doesn't see an
improvement until well into 2012.

Investors may get more insight
on Tuesday, when the Federal Reserve holds a regularly scheduled meeting
on the economy and interest rates. It's expected the central bank will
state that interest rates will need to remain at their current low
levels for at least another year.

Even with this bleak outlook, some analysts see a chance for stocks to rise, at least in the short run.

The
stock market could recover next week if European leaders make progress
in averting another debt crisis in that region, said Ryan Detrick,
senior technical strategist at Schaeffer's Investment Research.

Still,
even if stocks do rise, there are so many economic and political
problems to be resolved that any rally may well be very short-lived.